Alternatives to a Reverse Mortgage

Before you succumb to the temptation to tap into your home equity with a reverse mortgage, consider some of the other options available to seniors.

No matter how thoroughly you plan for retirement, life can cause expenses to spiral out of control. Whether an illness sends costs through the roof, or a stock market decline sends your portfolio into the basement, you may need to generate more cash than you anticipated. For older homeowners with substantial home equity, a reverse mortgage offers quick access to funds.

If you’re 62 or older, you can keep your house and receive a handsome sum that in most cases doesn’t need to be paid back during your lifetime. Closing costs are steep, and you need to remain in your home for a few years to justify the upfront expense. Yet for cash-strapped seniors with high home equity, low cash flow, and few other assets, a reverse mortgage can make sense, albeit as a last resort. Consider other options like REX Agreements, HELOCs, and lifestyle changes first.

Rex Agreements

A REX Agreement (http://www.rexagreement.com/guided_tour/window.html) can, in some cases, be a reasonable alternative to a reverse mortgage (http://www.houselogic.com/articles/is-a-reverse-mortgage-right-for-you/). You can convert up to 50% of your single-family home’s value into cash (maximum $300,000) by giving EquityRock, which administers the real estate investment agreements, an option to take a cut of the profit when you sell your house.

Unlike a reverse mortgage, it’s only available in 14 states-California, Colorado, Connecticut, Florida, Illinois, Maryland, Massachusetts, New Jersey, New York, North Carolina, Oregon, Pennsylvania, Virginia, and Washington-and age is no barrier. You must have a minimum 25% home equity and a good credit history to qualify.

Because a REX Agreement isn’t a loan, there are no monthly payments or interest charges. And while the comparison isn’t apples to apples, it costs much less to close on a REX than a reverse mortgage. If your home is worth $250,000, for example, you’d pay third-party closing costs for both a reverse mortgage and a REX of about $3,000.

For a reverse mortgage, you’d also pay a $5,000 origination fee and a $5,000 upfront fee for mortgage insurance. (Keep in mind, however, that reverse mortgage expenses are rolled into the loan rather than coming out of pocket.) When you sell your home, EquityRock will be entitled to a chunk of the proceeds.

The more profits you’re willing to give up in the future, the more money a REX will land you now. Let’s say you’re 75 and own a home valued at $250,000. If you opt for a REX with a 50-50 profit split, you’d receive $31,250 (http://www.rexagreement.com/index.php/form/calculator/). In a typical scenario, the same 75-year-old could take $67,742 from a reverse mortgage, about half of what he’d qualify for (http://assets.aarp.org/www.aarp.org_/articles/money/financial_pdfs/hmm_hires_nocrops.pdf), according to AARP.

If you sell in 12 years for $500,000, you’ll owe $203,771 on your reverse mortgage, which would leave you with $296,229. With a REX, you’d walk away with $375,000 (minus transaction costs and your original $31,250 advance). But if you sold your home for $750,000, a reverse mortgage would net you $546,229, while a REX would earn you less: $500,000 minus costs and the advance.

A REX really pays off if you sell your home at a loss after five years, when the agreement’s penalty period expires. In this scenario you’d keep the cash fronted to you and all of the sale proceeds. Remember, EquityRock is only entitled to a cut of profits. With a reverse mortgage you’d still need to pay back the loan.

Since EquityRock isn’t in the charity business, expect the company to offer less cash, or even turn down applications, in areas where there’s perceived risk that home prices won’t appreciate at an attractive pace. Also watch for low-ball appraisals, which can come back to haunt you when you sell and split the profits. Another area of concern is taxes. With a REX agreement, the money you receive is tax-deferred-you’ll need to pay Uncle Sam eventually. Consult a tax advisor.

Home equity line of credit (HELOC)

A HELOC (http://www.houselogic.com/articles/when-heloc-right-choice/) seems like a sensible reverse-mortgage alternative. You gain access to a line of credit, the money can be tapped when you need it for anything you want, rates are typically lower than those on credit cards, and you may even be able to write off the interest come tax time. The closing fees tend to be low too.

The first-blush advantages retreat as you probe further, however. With a typical HELOC, you make interest-only payments during the first 10 years. This is known as the draw period. After that, you’re required to make monthly principal and interest payments that are usually based on an adjustable rate.

Fall far enough behind and the bank can take your home. Lenders can also terminate HELOCs or reduce the amount available for borrowing. Another reason that a HELOC isn’t ideal for retirees is that qualifying means producing proof of income.

Lifestyle changes

Even though you love your home, if it becomes a financial burden, you may need to consider options other than borrowing. You could sell the house and rent a smaller one or an apartment. Some rents even include utilities. Or consider moving in with a family member. Don’t assume you’ll be a burden-you may actually take the burden off your loved one by pitching in with babysitting or cooking.

With the cash that you’d be pocketing from the sale, and your reduced living expenses, you could fund your retirement without taking on any additional debt. If you absolutely must keep your home, a part-time job will increase cash flow. Or consider getting a roommate. You’ll lose some privacy, but you’ll gain peace of mind.

Barbara Eisner Bayer has written about mortgages and personal finance for the past 15 years for Motley Fool, Daily Plan-It, and Nurse Village, and is the former Managing Editor of Mortgageloan.com and Credit-land.com. She splits time between a beachfront condo and a mountain retreat, which leaves her with double the pleasure and double the headaches of homeownership.

Source: Reprinted from HouseLogic (houselogic.com) with permission of the NATIONAL ASSOCIATION OF REALTORS® Copyright 2009. All rights reserved.